Crackdown On Mutual Fund Abuse

Wall Street’s top regulator, the Securities and Exchange Commission, is looking to crack down on U.S. firms that are improperly trading mutual funds. This past September, the SEC launched an inquiry into the trading practices of U.S. securities firms. So far, 80 of the nation’s largest mutual fund operators, including top brokerage firms, have received letters requesting information about how they buy and sell mutual funds.

The SEC wants to know the names of firms’ biggest mutual fund trading partners (including hedge funds) and those who have helped them reap the most cash. The goal is to determine whether any of the firms are involved in practices such as “late trading” or market timing schemes, allowing them to collect huge profits while potentially costing smaller investors billions of dollars.

Paul Roye, the director of the SEC’s Division of Investment Management and one of the agency’s highest-ranking African Americans, has principal oversight for the $7 trillion mutual fund industry and public utility holding companies. Roye spoke with BLACK ENTERPRISE about the alleged abuses and their implications.

BE: What prompted the investigation and what stage is it in now?

Roye: Our investigation was prompted by the New York attorney general’s complaint against Canary Capital Partners. Our examination and enforcement staffs are conducting a vigorous and broad-based investigation into these types of abuses. Where we find there have been violations of the federal securities laws, we will bring appropriate and meaningful enforcement actions.

BE: How does the so-called “late trade” maneuver work? What’s the right way and wrong way to conduct mutual fund trades under this concept?

Roye: [The law] generally requires every mutual fund and every selling dealer of fund shares to buy and sell the fund’s shares at a price based on the current net asset value that is next computed after receipt of the purchase or sale order. Most funds calculate their net asset values at 4 p.m. EST each business day. Purchase or sale orders that are entered before 4 p.m. must be priced at the net asset value calculated at 4 p.m. that day. Purchase and sale orders that are entered after 4 p.m. must be priced at the net asset value calculated on the following business day. Late trades would be those trades that are received after 4 p.m. but are processed as though they were received before 4 p.m.

BE: How could securities firms—and their clients or trading partners—that conduct improper trading practices benefit from this? How could individual fund investors be victimized?

Roye: Being able to put orders in after the 4 p.m. close [but get the 4 p.m. price], with the knowledge of events that happened after the close, provides these investors with an informational advantage that can allow them to capitalize on any increase in fund share value. This could be achieved by purchasing shares of the fund based on this information and then redeeming out of the fund after an increase in share price, all of which comes at the expense of those shareholders remaining in the fund.